Baba Kalyani: Creating an engineering giant

Published on Tue, Aug 04, 2009 at 14:00, Updated at Tue, Aug 04, 2009 at 15:11
Source: CNBC-TV18

Bharat Forge is known mostly as the global forging major and India‘s largest exporter
of auto component. It is a truly global group. Seventy five percent of its revenue
comes from outside India and not just via exports but from businesses located across
the world. In five years from now, it is most likely going to change. Bharat Forge, the
auto component company, is in the process of transforming itself into an engineering
giant.

It’s been a year of trial by fire at Bharat Forge. Close to 80% of the company’s Rs
4,800 crore revenues is earned outside India and most of it through the sale of
automotive forgings. The collapsing global auto industry hurt Bharat Forge’s core
business hard whereas the economic downturn squeezed the non-automotive
segment. In FY09, net profit dropped to 80% to just Rs 58 crore, but the worst is yet
to come.

Here is a verbatim transcript of the exclusive interview with Baba Kalyani, GK

Agarwal, Subodh Tandale and Amit Kalyani on CNBC-TV18. Also watch the
accompanying video.

Baba Kalyani, the Chairman and Managing Director of Bharat Forge

said, ―Last year was challenging but I think the worst year is going to be
this fiscal. Although we are beginning to see bottoming out in India and
the economy here beginning to catch up but in terms of global markets in
this business 09 calendar year would probably be the most difficult and
most challenging.‖

Q: So it's going to get worse from here on before it gets better is what you are
saying. How much worse?
Baba Kalyani: The problem is that in 2007 even till middle of 2008, everybody was
working on the basis that the markets will grow. So everybody was buying a little
more than they were consuming and now you have this huge inventory overhang. The
inventory overhang is going to take a lot of auto companies something like four to five
quarters to get rid of and then you will really start seeing real demand. So at a
component level what we are seeing right now is two factors. One is the market has
shrunk, the total output of the industry has shrunk and buying has shrunk even more
because of the inventory overhang.
Q: What are some of the signs you are going to look for to judge whether the
environment is truly improving or not? Is it going to be things like the rundown in
inventory levels or things like that?
Baba Kalyani: There is a very large overhang of inventory and they are coming down.
Our estimate is that inventories will come down to almost let‘s say just the basic
operational level by end of this year. So you will start seeing purchasing or quantities
almost double by end of this year even if the sales remain at current level. So we will
see volume growth. It may not be the same levels as 2007 but quite substantial
volume growth from where we are today and that's a very clear sign. Now where will
it go going forward that's anybody‘s guess? Our intelligent guess is that it will take a
long time maybe four to five years for the industry to get back to the peak levels of
2007-2008. So you will see this industry coming back to something like 80-85% off its
peak levels which for us is very good.

Q: In the next three or four years?

Baba Kalyani: No. Let‘s say by the middle or end of 2010.

Q: And that's where the global market, as far as the Indian commercial vehicle
market goes what's your outlook because I know one of the companies that we
profiled on the series is Ashok Leyland and Seshasayee was saying, ―I am finally
seeing signs of a turn around‖ so you are hopeful that are you seeing the same?
Baba Kalyani: Yes. We are seeing the same signs of a turnaround. We are beginning to
see higher demand but it is not still at the level of 2007 or 2008. It came down 60-65%
so it's now coming back but its still 30-40% below where it was. But my gut feel is that
with whatever steps the government has taken the last stimulus package before the
election—the December-January stimulus package—I think that has had some impact
on the commercial vehicle business. The bus demand has gone up because of the
urban renewal mission programme, which is beginning to bite in. Infrastructure
spending will bite in and create demand for vehicles. So we are very optimistic about
the commercial vehicle industry at least in India.

In 1999, Bharat Forge focused on exports to reinvent itself into a global player. Four
years ago it adopted the merger and acquisition (M&A) route to expand to 12
manufacturing locations across six countries. Now, the very existence of some of its
international subsidiaries like Bharat Forge America and Scottish stampings is under
threat.

―I don't think I would have done things differently. Nobody forecasts it that the global
economy is going to go through such a large meltdown. Now, if we were to do this
exercise, starting today, we would again do the same exercise except that you would
get businesses that have already restructured to today's market situations. We bought
businesses that were structured for the demand levels that existed at that time and
which was a growing demand and okay what does mean, it means you have to
restructure your businesses you need to downsize your businesses,‖ Baba Kalyani said.
 Amit Kalyani, Executive Director, Bharat Forge, said, ―Too much
growth is not good for you that is one thing and when you are growing
keep your eye on at what cost are we growing. Sometimes when you tend
to grow too fast, you tend to lose focus of a lot of key metrics because
your customers are breathing down your neck they are always pushing
you for more and at what cost are you doing that more.‖

Further, Baba Kalyani, said, ―We were kind of carried away of just simply growing our
business, call it market share or just topline numbers. The smarter thing to have done
would have been to plan for ‗x‘ percentage of this growth on a base capacity basis
and then create flexible capacity for 25-30% of the demand. Then the pain is much
less because the flexible capacity you can get rid of that flexible capacity in 10 days
or you can shut it down. You got dedicated capacity it takes anywhere between six to
12 months, depending on the geography you are in, to downsized it because you have
to give notices to people where there's certain contractual time, there's a certain
negotiation with unions etc. So, I think this is the only lesson, the only hard lesson
that we have learnt and we are going to implement this going forward. That we are
going to create flexible capacities which will deal with the markets ups and downs in
a much easier manner financially than the pain we are going through today.‖

Q: Many of your subsidiaries are still struggling, partly because of the external
environment and partly because like you said, when you bought them they were
in a fattened state and not lean and mean. Is there likely to be any asset
restructuring on your end?
Baba Kalyani: We have done. As a matter of fact, a large part of our re-structuring in
Europe and the US is already finished. We have taken a very aggressive position in
terms of where we see the demand coming. So we have re-structured to like 50%
levels. In the US we have restructured to maybe even less than 50% levels because the
peculiar play in the US with the small truck business which I think is going to go down
quite substantially. So we have done this and that‘s restructuring as far as we are
concerned.

Q: Is it going to mean in asset sales of any kind?

Baba Kalyani: No. We are not selling any assets.

Q: Are you likely to shut down any of your subsidiaries?

Baba Kalyani: We might because we just have too much capacity. When you go to 50%
capacity it just doesn‘t make sense to keep all your plants running. But we haven‘t
made that decision yet we will make that decision.

Q: Which of the regions look the weakest?

Baba Kalyani: In Europe we have six plants in Europe and we could do with five
instead of six. It doesn‘t really make any sense. But we have not made that decision
yet. We will make that decision once we get a little more clarity from our customers.
 GK Agarwal, Deputy Managing Director, Bharat Forge, said, ―It made
sense to have small operations at some locations for certain reasons but
if that business is so low now, that it does not make sense to continue it
is better to combine it with something else.‖

Q: Would you like to give some illustrations of that?

GK Agarwal: For instance we have been some issues with the volumes being very low
at Scottish Stampings in UK. It is a single press operation. Thus, that is an operation
that could possibly get reorganized.

Subodh Tandale, Executive Director, Bharat Forge, said, ―We are

looking at optimising our large presses in Europe, we are looking at may
be optimising our passenger car production in Europe and North
America.‖

Q: How much have you been able to reduce costs by?

Subodh Tandale: On an average we have been able to reduce costs in a region of
anywhere between 10 to 12%.

Q: In the last one year?

Subodh Tandale: I would say six months.

Q: Is there more headroom?

Subodh Tandale: Our intention is to try and do at least 50% of that in the next one
year.

A new 2008 facility to forge a 27 tonne ingate into a sugar mill crusher by a 4000 ton
open die press is the result of a change in strategy four years ago when Bharat Forge
decided to apply it’s metals, forging, machining and surface treatment abilities to
the non automotive sector since then the company has signed up three joint ventures
with NTPC, Alstom and Areva and invested Rs 500 crore in two new facilities. It hopes
to push the contribution of non auto revenue from 18% last fiscal to 50% in FY12.

―We were reaching a level of saturation in our automotive business. We had reached
markets shares globally of 30-35% in most of our key operating product segments that
to go beyond that would be a very high risk situation and very difficult to do. So we
needed a new growth engine for ourselves and we created that. We also created that
to de-risk ourselves from the cyclicity of the automotive business not from a financial
meltdown—that was not the idea. But the automotive business has a four-year cycle
because of new emission norms coming in every four years so new technology comes
in every four years so new cycles happen. So we wanted to insulate ourselves from
this cycle so we started on this strategy,‖ Baba Kalyani said.
Seconding his opinion, Amit Kalyani, said, ―These are opportunities that are the
beginning of Bharat Forge‘s transformation from being seen as a components player
alone largely for the automotive sector transitioning into an engineering
conglomerate where we use our knowledge of metals, metal energy, manufacturing
and design engineering to become a capital good and engineering conglomerate. So
this is the route and a path that we are on and I believe that this is the journey that
the next five years will see.

Q: What is the size of the business opportunity? What do you think realistically
speaking you can do in five years?
Amit Kalyani: When we had done our homework about three years ago we had seen
that our automotive forging opportunity was roughly 30 billion globally for what we
wanted to target and for the non-automotive, in the areas that we are talking about
the opportunity is somewhere in the 30 to 40 billion range. If we are looking at similar
market share of what we are trying to do then it will give us a size of business, which
is roughly the same as our automotive business. At our peak year we did Rs 4,500
crore of revenue off even if we see 80% is automotive that is Rs 3,500 crore so in a
five year period you have the opportunity to create that kind of a business.

GK Agarwal: The timing for these opportunities could be different. For instance,
power is a fairly mature business in this country so long as we are ready, we are ready
to supply. For example BHEL today imports all of its requirements from outside. The
moment I‘m ready, I will have large opportunity waiting out there.

Q: How large?
GK Agarwal: This opportunity could be almost Rs 1,000 crore a year.

Q: So that brings to the question of scaling up—you need to be ready to be of a

vital size in the next two years when, let’s hope, the global economy has turned
and therefore you need to be ready with that much more capacity. I know this one
and the Baramati one, a recent ones that have come on line in that sense but
resources are tough to come by, you have the FCCB to repay by FY11?
Baba Kalyani: The difference is when we set up these capacities we set them up to
world scale.

Q: So you won't need to add more?

Baba Kalyani: I can simply ramp up the output here three times.

But till that happens automotive forgings will be the main stay at Bharat Forge. Sales
to the commercial vehicle industry make for half the company’s revenue. But that
could reduce due to the sharp cuts in demand this year and growth in other
businesses.

Baba Kalyani: As far as commercial vehicles business is concerned, we don‘t see this
market shrinking. In Europe, as I said, maybe 20% of the market will go down. But if
you look at a past five-year average, we will still be at the same level or a better
level for the next five years. In the past five years the US market has been at a very
low level—almost at 60% level of the normal. We expect that market to kind of go up.
And I think in India and China these markets are increasing. So commercial vehicles
we see opportunities and clearly have the capacity in place, we don‘t even have to
add any capacity for the next five years for this market.

Business with the passenger car industry makes for a fourth of Bharat Forge’s
revenue while that size will continue the contributing countries and cars will change.
Baba Kalyani: In the passenger car business as far as we are concerned, we have
three geographies that we must look at separately—China, India and the rest of the
world. I think in China and India, we will continue to grow our passenger car business
as the market grows. So I think we will be able to continue our market shares and
continue to grow it. We are beginning to see this in China. As a matter of fact, we are
now going to invest in some new facilities in China for passenger cars, for making
some different components. For the rest of the world, the market will fall on the
passenger car side. So this is one trend.
The second trend is there is a trend towards smaller vehicles, smaller engines and
smaller components. So if you calculate in weight, you are going to have less weight
per car. Third, there is a trend in new technologies, whether it‘s electric, hybrid or
whatever it is, we are beginning to see a lot of electric things happening. So these
issues, on a global basis, you are not going to see an expansion in terms of numbers.
The only way you can grow is consolidation and new technology. So our focus in the
rest of the world is purely based on a consolidation strategy and new technology
strategy.

Q: When you say consolidation can you elaborate on that.

Baba Kalyani: That‘s difficult to elaborate on but you know what I mean.

Q: It was a question I was going to ask you towards the end?

Baba Kalyani: Clearly the opportunities for consolidation are going to be there.

Q: They already are right because of the shake out you’ve seen in the auto
industry.
Baba Kalyani: I think right now there are lots I get proposals everyday. But the
baggage is still there. No one has defined a way to get rid of the baggage. Now that
will happen once the whole picture about GM, Chrysler and its suppliers becomes a
little more clearer and the courts and the Us government decides which way this
whole thing is going to work.

Q: So you still have appetite for consolidation.

Baba Kalyani: It‘s going to happen.

Q: Every business leader I know has overeaten when it comes to M&A?

Baba Kalyani: I don‘t think I am actively looking for an M&A. But in our industry,
which is a supply industry, where you are excess capacities because the demand itself
has shrunk to a large extent without consolidation the industry would not survive.
Let‘s face it.
Subodh Tandale: Asset sales are available but for relatively smaller companies. You
know where you‘re looking at revenues anywhere between range of USD 50-80 million
and upwards of about USD 150 million.

Q: So what size would you be looking for?

Subodh Tandale: Traditionally, we have looked at anywhere between USD 150-200
million as a size. But we are also looking at sectors which are different. We are also
looking at non-automotive. So we are really not hung up on the ticket size at this
point we are looking at it from more of an opportunity standpoint.

Q: Which geographies do you see these opportunities in?

Subodh Tandale: At this point we are seeing a lot of opportunities in Europe, in
Germany and in the US. We are also looking at some of these deals in a way where we
can look at a short-term approach, where we don‘t really need to go in for asset sales
or purchases. We really want to go in for business books and you know use our
capacity, either in India or overseas, to be able to address them.

Q: So final question this is interesting, about 2 or 3 years ago all those Indian
companies that lived the life of a frog in a well and chose to ignore the global
world suffered because there was so much global growth and liquidity, your
company prospered in a situation like that because you were out there making
businesses in all these countries and now increasingly for many Indian companies
the Indian market itself are on both counts A because it is growing while the rest
of the world is not B this government is focused on making sure that middle India
grows and that middle India can be a very big consumer we have no clue how big it
can be right so suddenly all things have come back home – what does that take for
you to re-focus or re-align your business and say we want it to be a global player,
we went out there but now the domestic market is going to be equally important if
not more who knows 5 years down the line.

Baba Kalyani: For us you know the domestic market has always been important – it‘s
not that we have ever treated it less important.

Q: But 25% of you consolidated revenue?

Baba Kalyani: But our market share with every customer is in excess of 60%. I think
what has happened now with the government‘s approach in putting focus on
infrastructure is a large part of the infrastructure play that was not available to
companies like us is now going to be available – power sector for example. If you
looked at the power sector for the last 25-30 years you had one company
predominantly playing NTPC no or BHEL in manufactured products NTPC is the utility,
power equipment manufacturer. Now suddenly this field is open to people like me and
we will be there in that business. So 5 or 7 years from now I should be producing 5000
mw of turbine and generators. Now these opportunities are coming up. The same
thing is happening with the nuclear opportunity.
Q: So finally 75% of your consolidated revenue comes from outside India, you’re a
globalised company, 5 years down the line could in quite likely be, I won’t say the
reverse, but half and half.
Baba Kalyani: I think it will be more than half and half—our India centric revenues
will be more than 50%.